Moneyball without the ball

Archive for

The long wait for Vicor to post a step change in results is over. With the release of the fourth quarter there was an end to the delays and they put out some solid concrete numbers. To be sure, the fourth quarter itself was not very good (this was expected), but guidance and color around what to expect next quarter and beyond was very positive.

Here’s a summary

Backlog at the end of the fourth quarter sat at $73 million compared to $60 million at the end of the third quarter

Bookings grew 11% sequentially to $71 million

Bookings thus far in the first quarter were $55 million (through 8 weeks of a 13 week quarter)

They expect sequential bookings improvement throughout the year

As is typically the case, Vicor gave hard data on the next quarter but you had to piece together the long-term picture from circumstantial evidence and color. This quarter we got to extrapolate from their comments on facility expansion.

Vicor has a 240,000 sq. ft. facility in Andover, MA. They said on past calls that they can produce $400-$600 million of revenue from Andover. In the fourth quarter updated/reiterated that this number at $500 million.

In the past Vicor has talked about adding capacity by purchasing or leasing additional space nearby. From the second quarter call:

…we’re also actively looking for incremental space nearby, not far away from the Andover facility, to further expand capacity in about 1-year time frame

On the third quarter call they hinted that this plan might be evolving as they were leaning towards building their own facility. Last week they confirmed this was the case, and in the process gave us a hint about where revenue might eventually go:

…we’ve had a change of plans regarding that. What we concluded after investigating certain options in the neighborhood of our existing Federal Street facility is that a building of the order of 80,000 to 100,000 square feet would not serve our long-term needs. So we were able to secure a deal with a partner to help our short-term capacity requirements to give us some breathing room for breaking ground on larger lot with considerably more room for expansion. So we’re looking at options for as much as 250,000 square feet, which would be equivalent in terms of capacity to our Federal Street building.

So the circumstantial evidence that we got is that while they have a $500-$600 million revenue facility, they have decided to forego a 100,000 square foot addition via an existing nearby building in favor of building another $500-$600 million facility. They are taking this course of action because they think they would outgrow the smaller facility.

Conclusion

The reason I have been in Vicor is because of the potential for big revenues as they ramp product for 48V servers, for automotive, and for high-end FPGA’s that utilize power on package technology. They have always been vague about how big these opportunities might be. With the fourth quarter results we started to get some sense of that size.

To be honest, the opportunity needs to be big, because the stock isn’t particularly cheap. At a $27 share price the enterprise value is about $1 billion. Trailing twelve month revenue is $227 million and EBITDA is non-existent.

Looking forward, if we get 50% growth in 2018 and if gross margins improve to 50%, I estimate that EBITDA should be around $70 million if most of the gross margin falls to the bottom line. That gives Vicor a 13.5x EBITDA multiple.

Vicor starts to look cheap if you think they can get to $500 million plus of revenue. Again, assuming a modest increase to operating expenses (I’m guessing $140 million annualized), and an uptick in gross margins to 52%, I come up with $135 million of EBITDA, which would give Vicor a forward multiple of 7.5x.

Of course if you start factoring in the second facility, you are looking at $1 billion plus revenue and then the stock clearly has further to run.

So that’s the potential trajectory. It’s actually always been the big picture that I have hoped would play out. With the fourth quarter numbers and first quarter guidance, that picture is a little less presumed and a little more expected. Its still a long way from being a sure thing, but its moving in the right direction. And that’s why you have gotten the move in the stock that you have.

This idea is bound to generate a lot of skepticism. Its the kind of wildly unprofitable, clever but challenging, just getting off its feet sort of business that a lot of readers are going to recoil at and probably tell me why it’s an inevitable zero.

And that’s okay because that is definitely a potential outcome here.

I got this idea from @teamonfuego on twitter so hat tip to him. I don’t think he owns it any more though.

Here’s the story

DropCar is actually two businesses. It is DropCar, which is a start-up valet and parking service, and it is WPCS International, which operates a communications infrastructure installation business.

These two businesses came together via a reverse merger. DropCar took a little under 85% of the capitalization while WPCS took 15%. The transaction closed at the end of January.

DropCar

DropCar is a fairly recent start-up. The company was formed in 2015. They operate exclusively in New York City. There are lots of articles available explaining the business and how the service works (here, here and here for starters).

DropCar offers a basic car garage alternative, a hourly chauffeur service, a premium service and a B2B service.

The basic service, which they call STEVE (they use people’s names for each of their offerings, I guess to mimic that its like a virtual valet or chauffeur), allows you to have your car parked at one of their garages, and when you need your car you arrange a pickup and a driver will bring it to your door. Similarly, you arrange a driver to meet you to take your car back to the garage. The service goes for $379 per month.

With the hourly service, the driver comes to your door but stays with the car through your travels and drives you around, eventually dropping you off and taking the car back to the garage. The cost of this service is $15 per hour.

The new premium service was launched in January. For a higher monthly fee ($499 per month), you get all the benefits of STEVE along with a maintenance and care program.

The B2B service arranges pick-ups of vehicles for maintenance by dealerships, fleet leasing centers or other auto-care facilities. DropCar has a reasonably sizable list of New York based dealers that have offered this service: Mercedes of Manhattan, Lexus of Manhattan, Jaguar, Land Rover of Manhattan, Porsche and Toyota.

DropCar is also trying to develop a critical mass of drivers wherby they can leverage their model to participate into the new “flat fee service” option being offered by dealerships. This is where consumers pay a subscription fee on a monthly basis. Its early, but it’s in the trial stage by by many dealerships (other articles here and here). DropCar would be like the delivery man for these services, picking up and dropping off cars and bringing them in for maintenance when required.

They are also looking to leverage the data they collect. They began to hint at in this recent excerpt of a January press release:

Not only does it harvest an increasingly valuable trove of big data (e.g. consumer auto-related data), but it proactively benefits from best-of-breed sources such as Google and Waze. Along these lines, DropCar management eventually plans to monetize its software/middleware platforms and big data harvests through licensing agreements.

Failed Model

DropCar is not the first to try this sort of business. They were preceded by Luxe and Valet Anywhere. These companies did not fare well.

Historically, companies such as Luxe, which closed operations in July 2017 and subsequently sold their technology to Volvo in September 2017, as well as Valet Anywhere, which closed operations in July 2016, have unsuccessfully tried to build similar on-demand service models.

DropCar differentiates itself from these failed attempts in a few respects. They say the mistakes of their predecessors was due to:

use of expensive in-city garages

parking-only focus

low valet utilization rates tied to only servicing consumers (B2C)

DropCar is trying to correct these mistakes by arranging garage space at the edges of cities, providing higher margin services like the usage of the personal valet and the business to business solution (B2B) being offered to dealerships and fleet owners, and trying to integrate all the services at a scale where they can efficiently utilize their drivers.

I don’t believe that DropCar is primarily interested in the consumer business, though that is the easiest and therefore has been the first to ramp. I think the B2B business will eventually be the better opportunity. In the latest update the company said the following:

In anticipation of a substantial enterprise expansion, DropCar recently converted a large portion of its seasoned valets into field management roles. While this transition momentarily tempered valet-base expansion, it enables DropCar to efficiently absorb the anticipated demand surge in 2018 from Tier-One automotive OEMs, dealerships and concierge service subscribers.

Its also clear that this is going to work better in some cities then others. New York City is ideal. The company identified Los Angeles, San Francisco, Chicago, Dallas, Miami, Boston, Washington DC, and Philadelphia as US expansion destinations. Globally they see Beijing, Shanghai, Tokyo, Singapore, London, Paris and Rome as possible expansions. But I don’t expect the business to be able to scale like an Uber, because many cities aren’t big enough or are too sprawled out to make the service effective. Luckily the stock is cheap enough that it doesn’t have to.

Rising Revenue but no Profitability

DropCar is growing, but they are not profitable. Below on the financials from the prospectus for the first 9 months of the last two fiscal years.

The company was actually closer to profitability in 2016 then in 2017. Gross margins have shrunk in 2017 and expenses, particularly G&A expenses, have risen.

You can spin the gross margin decline two ways. Either its evidence of a soon-to-be failed model, or it is evidence that they are ramping up for growth. I’m betting on the latter. Below is an excerpt from the prospectus (my highlight):

DropCar increased its valet workforce by 75 employees to 110 full time employees, or a 214% increase during the nine months ended September 30, 2017 as compared to September 30, 2016. This increase is based on increased demand in valet services, as well as anticipated growth in the next three to six months.

Similarly, the rise in G&A can be explained by expansion and costs associated with the reverse merger. About $850,000 of the year over year increase was attributed to payrolls, another $900,000 to merger related legal fees, $410,000 due to advertising and recruiting and $650,000 due to stock options.

Current Revenue Run-rate

According to a recent company update, the consumer subscriber base is currently more than 1,400, which is up from 500 at year end 2016 and 1,000 at the end of June. Automotive movements were also up significantly:

Overall consumer automotive movements exceeded 28,000 during the fourth quarter of 2017, up from approximately 10,700 in the fourth quarter of 2016. Quarterly enterprise movements have eclipsed 5,700 versus approximately 2,000 a year ago.

Based on the monthly rate of the base consumer business ($379 per month) and the current user count, the revenue run rate from the consumer business is $6.3 million. I’m not sure what the revenue is from the B2B business. The best I can do is extrapolate from their summer presentation. In it they said they had an overall $5 million revenue run rate from about 1,000 subscribers. This implies the B2B business was around $800,000 at the time. Assuming some growth to the B2B, I’m going to guess that the run rate of the entire business is about $7.5 million right now.

WPCS: Merger and Business

The reverse merger with WPCS International seems to have been initiated by a large holder of DropCar, Alpha Capital Anstalt. Presumably DropCar agreed to go public because of the access to capital, which they will undoubtedly need more of. I’m not sure why they decided to go the reverse merger route instead of an IPO. That is always something to be wary of and if anyone can shed light on this it would be appreciated.

WPCS has operated an unprofitable communications installation business for some time. They upgrade cabling and wireless infrastructure for institutions like hospitals, schools and government offices.

The business did $16.7 million of revenue in fiscal 2017 and $14.5 million in 2016. It consumed $1.3 million of cash flow in 2017 and $2.6 million in 2016.

In a comparable company analysis performed as part of the merger agreement, Gordian found a fair value based on revenue of $10-$11 million and based on EBITDA of around $4 million.

Originally I bought some shares of DropCar when the stock spiked on Tuesday. I unfortunately bought into the spike at $3.15, and that was a mistake. I briefly looked like a genius as the stock rose to $3.50 but that quickly turned into a fool.

I wasn’t planning on buying more, but as I dug into what happened on Friday and then Tuesday, I came upon this disclosure from Alpha Capital Anstalt.

As part of the terms of the merger, DropCar needed to raise at least $4 million in capital. Alpha stepped up and provided the liquidity for the raise. However this took Alpha above their maximum allowable ownership, as this disclosure notes:

All of the foregoing securities issued to Alpha contain a 9.99% “blocker” provision designed to prevent Alpha from being a beneficial owner of more than 9.99% of the Issuer’s Common Stock.

I haven’t found it yet, but I bet they had something like a 30 day grace period before they had to get their stake down below 10%.

This is essentially what occurred on Friday the 16th, Tuesday the 20th and Wednesday the 21st. There were two 13-D forms (here and here) issued by Alpha where they disclosed that they had reduced ownership significantly, eventually down to 9.9%. In the second it was noted they were no longer in breach of the terms:

Does not include shares underlying the Series H-3 Convertible Preferred Stock nor the four classes of Warrants that Alpha Capital Anstalt (“Alpha”) can beneficially control under a contractually stipulated 9.99% ownership restriction. The full conversion and/or exercise of Alpha’s securities would exceed this restriction. Alpha’s ownership is now below 10%.

It is likely not a coincidence that the share dump by Alpha corresponded with high volumes and wild price swings in DropCar on the 16th, 20th and 21st:

In my opinion its unlikely that any of the prices we’ve seen since the closing of the merger agreement (January 31st) are particularly reliable indicators of the business’s value.

The stock began to tank from $4.50 down to $2.50 almost immediately after the merger closed. I think its possible that Alpha began selling as soon as they could, knowing that they had to get their stake down to below 10%. I think it’s also possible that other investors gamed the stock, knowing that Alpha was going to be a forced seller regardless of price. I did find reference to the disclosure about the blocker as early as February 5th, though there was more implied language of it much earlier in the prospectus, which was available back in December.

Who knows what really happened. Nevertheless it seems a reasonable bet it had little to do with the fundamentals.

Conclusions

Like many of the stocks I take a chance on, DropCar is no sure thing. There are failed precedents, they are losing money, and while the Alpha pre-merger capital raise brought in $4 million in cash, that is still likely only enough to get them through this year.

What I like about the stock is that the top line is growing and there is evidence it will grow further. In particular, the company is expecting a surge in the B2B business. From the recent company update (my highlight):

In anticipation of a substantial enterprise expansion, DropCar recently converted a large portion of its seasoned valets into field management roles. While this transition momentarily tempered valet-base expansion, it enables DropCar to efficiently absorb the anticipated demand surge in 2018 from Tier-One automotive OEMs, dealerships and concierge service subscribers.

Following the merger there are 7.8 million shares outstanding (from here). The market capitalization is around $20 million at the current price ($2.50). If I’m right about the current revenue run rate ($7.5 million) then the company is trading at a little over 2x DropCar’s current revenue run rate. Given the growth rate, that’s not particularly expensive.

As I pointed out above, the WPCS business could be worth anywhere from $4-$10 million in its own right. I would imagine that gets divested at some point to bring in more cash. There is also the $4 million of cash on the balance sheet,though this is going to get burned through this year.

But here’s where it gets really interesting. In the merger prospectus Gordian performed a similar competitive valuation analysis for DropCar to what I showed earlier with WPCS. Here is the valuation table they came up with:

As you might expect, the valuations are quite different depending on whether you look backwards or forwards.

The forward numbers are pretty interesting. In particular I believe you can back out 2018 guidance from this analysis.

It looks like Gordian (presumably under DropCar’s advisement) is estimating 2018 revenue at more than $19 million, or more than triple current revenue and a 400% increase over 2017 (please refer to my note below, its really important to see how I got this number). I don’t usually bold things in these posts but that is a big number and I think its worthy of attention, both to consider and also to verify that I haven’t screwed something up.

(***Let me explain how I came up with my more than $19 million estimate. First, I think they have their mean and median columns mixed up in the table above. You can’t make sense of the numbers if the higher multiples are giving lower valuations. As well, the revenue numbers only line up if you switch the mean and median columns of the Comparable Company Values. For example, looking at the 2018 revenue line item, 80.7/4.08 is $19.77 million of revenue. Similarly, 53.5/2.73 is $19.6 million of revenue. So about the same, as you’d expect. But if you lined up the mean and median columns you’d get 53.5/4.08 and 80.7/2.73, in which case the revenues wouldn’t match up. Therefore I think the columns are flipped in the Comparable Company Values rows and that’s how I came up with the $19 million number.***)

Like I mentioned above, I don’t think the current price is necessarily reflecting anything other than the forced selling of Alpha. On top of that you have a stock that just went public via a reverse merger with a kinda crummy little communications business that nobody cared about. You have very few followers other than some day traders that are hitching themselves to the ride up and down and don’t really care about the business one way or the other. And you have a market capitalization that is tiny enough to be ignored by any fund. So there’s no interest in the stock yet.

If, and this is a big if, DropCar can get to the kind of revenue number that Gordian’s projections assume, that’s going to change. There is no way this should be a $20 million company if it can grow revenue like that. Its got to be WAY higher.

If they don’t grow revenue then it’s probably a zero. So that’s the risk and the reward. Its the kind of situation that is either going to crash and burn or go through the roof. Just the sort of option I like.

On Thursday Gran Colombia announced the warrant terms of a $152 million USD senior secured note offering. Attached to the notes the company is offering 124 warrants priced at $2.20 per share per $1,000 of note principle.

Dilution amounts to 18.8 million shares. This compares to 72.2 million shares that would have been issued under the existing 2018, 2020 and 2024 debentures if they were fully converted (the table below is from the third quarter MD&A filing).

I think the deal, if it is approved, is pretty positive. Consider:

Under the prior share structure, a $2.50 share price translated into a market capitalization and enterprise value of about $230 million (~92 million x 2.50 = $230 million).

Under the new notes, and considering redemption of all of the existing debentures at par, the share count is roughly 39 million and the market capitalization is $97.5 million (39 million x 2.50). The enterprise value is $202 million (97.5 million + $150 million (x 1.25 CAD/USD exchange) – $45 million (assuming in the money warrant conversion of the 18.8 million warrants) – $9 million).

Debenture Holders can participate

As a debenture holder (I own both the stock and some of the X and V debentures) I’m interested in what my options are with the debentures.

The terms gives existing debenture holders the right to participate in the offering:

Existing holders of the Company’s Outstanding Debentures that are eligible to participate in the Offering may (subject to complying with certain procedures and requirements) be able to do so by directing some or all of the redemption proceeds from their current debentures into Units on a dollar-for-dollar basis.

I’m not entirely sure how to read this. Does it mean that existing debenture holder gets preference to convert their debentures into new notes or is this just on a best efforts basis where an over-subscription to the notes would mean partial allocation?

I’m hopeful that I can direct my debentures into the new notes, but I’m not counting on it.

Its still cheap on Comps

Gran Colombia continues to compare favorably to other gold producers.

One of the quick scans I like to do compares companies on a simple EV/oz produced basis. I’ll do the comparison and then weed out why some companies trade at lower multiples than others. Usually there are good reasons.

At $1,400/produced-oz Gran Colombia trades at one of the lowest multiples of the group. Only the really poor operators that are cash flow negative at current prices (an Orvana Gold for example) are cheaper. Most of the companies I compare to are in the $4,000 – $6,000 per produced-oz range. Even the lower tier companies like Argonaut Gold or the struggling one’s like Klondex trade at over $2,000 per produced-oz.

Its still cheap on Cash flow

Even forgetting that it is a gold stock, Gran Colombia remains reasonably priced as a business.

On the third quarter conference call Gran Colombia reiterated guidance for $16 million USD of free cash flow in 2017. In the fourth quarter they produced 51,700 ounces versus an average of 40,700 ounces per quarter in the first three quarters.

The indication after the strike at Segovia was that new agreements with artisanal miners should lead to more processed ore at the plant. Based on this and progress at the Segovia mine, my expectation is that 2018 free cash guidance will exceed 2017.

I suggested in my original post on Gran Colombia that I thought $20 million USD of free cash flow was not an impossible goal. I still think that’s possible. Assuming the note and debenture deals go through, the market capitalization of the company will be a little under $100 million CAD at current prices. Even though the stock has climbed since my original post, this still means the stock is at less than 4x free cash flow.

Conclusion

Eventually the note offering and debenture redemption should be positive for the stock. But it might take a few months.

What’s tricky is that at $2.40 the stock price is right about where the debentures convert. It isn’t really in anyone’s interest (other than the current debenture holders, though even that is debatable) to see the stock price rise too much above the convert price until the deal is done.

I’ve been adding to Gran Colombia all the way from $1.40 to $2.20. I see no reason to take any off the table yet. The company is doing everything right so far. Hopefully with the new capitalization and simpler structure the market will continue to recognize this.

Revenue in the fourth quarter was $10.6 million. They turned a nice profit, about 17c per share. But the big news was announced on the conference call. A new Tier 1 one win:

We are very excited to share that one of these major NFV trials has come to fruition and resulted in RADCOM being selected by a Tier-1 multi-carrier operator. We expect this to result in a formal contract during the first half of 2018 and we’re making preparations for project execution.

Radcom also gave us some guidance for the first quarter and for 2018. They said first quarter revenues will be below the fourth quarter. And they said 2018 revenues will be $43 million to $47 million.

What to make of it?

Let’s go to the comment, which was made by Arf. Arf correctly pointed out that if Radcom grows by 25% in 2019 and 2020, after hitting the midpoint of guidance in 2018 ($45 million), then the upside is not as much as you’d think. He estimated the stock had maybe 70% upside if they got a 20x earnings multiple. This is in 2020 mind you. Given those assumptions, I think that’s probably fair.

So if that’s the upside, why bother with the stock?

My take is this. Because Radcom customers are large Tier 1 service providers, the deals are slow and sporadic but also unusually large compared to the existing revenue base. This combination makes it hard to anticipate the growth rate. Growth is going to be lumpy and its going to depend on the timing of when these deals are signed and when they begin to on-board.

Let’s look at exactly what 25% growth rate is assuming:

So after growth of about $8 million in revenue in 2018, 25% growth adds another $11 million in 2019, and then $14 million in 2020.

That’s a possible outcome, but I don’t think it is an optimistic one. After the announcement today of the third Tier 1 win I would say it’s also less likely.

I’ve been looking at it like this. From the fourth quarter results released today, we know that total revenue for the year was $37.2 million and AT&T accounted for 60% of it. So the deal with AT&T was worth over $22 million in revenue in 2017.

I’ve always assumed that a full win on Tier 1 account should be for at least $15 million. Based on what we are seeing with AT&T, that assumption seems reasonable. It might even be low if Radcom can penetrate these other carriers to the same degree they have with AT&T (ie. sell them on the new visibility product that they will be unveiling at Mobile World Congress in a couple of weeks).

The Verizon foot in the door win was for $5 million. My bet is that eventually Verizon will grow to close the size of AT&T. Let’s say Verizon can be an $18 million win as the deal matures. Other large wins (with say a Telefonica or a Vodafone or a Bell Canada) should at least be $15 million.

With those numbers in mind consider this. A $19 million increase by 2019 ($8 million in 2018 and $11 million in 2019) is really saying that by 2019 Radcom will have successfully integrated Verizon to a similar level as AT&T and not much else. A $14 million increase in 2020 is saying that Radcom finally gets a single third carrier win by that point.

If it’s into 2020 and RDCM only has AT&T, Verizon and one more win, then something has gone horribly wrong with the thesis. Either NFV isn’t getting adopted or a competitor has caught up or something.

What do I want to see?

The difficulty this past year (and what led me to sell out of my position entirely for a couple of months) has been that the lumpiness of the wins has played against Radcom. They had no new wins that contributed to 2017 revenue. They were lucky to have a ramping business from AT&T that allowed for growth in the absence of new deals.

This handicap could become an asset over the next year. Because of the large, lumpy nature of their deals, even if Radcom gets just two wins per year for the next couple of years the company’s growth rate should go up substantially.

If I assume that Verizon is an $18 million deal in 2019, that the just announced Tier 1 is a $15 million deal in 2019 and that two more deals are announced in the next year and a half and begin to contribute meaningful revenue in 2020, I get a very different picture:

These numbers assume that by 2020 Radcom has 5 wins worth of revenue, ie. AT&T, Verizon, the announced win today and two others that will be announced in the next year and a half Its hardly more than one more win a year. In my opinion, this is not wildly optimistic.

So what’s with Guidance?

Any astute bear on Radcom is going to focus on the guidance. At first I was surprised it was as low as it was, given the Verizon win and the newly announced Tier 1. They did $37 million in 2017. The midpoint of guidance is $8 million higher.

But after thinking about it more, it makes some sense. We know the first phase of the Verizon deal is $5 million. We know this new Tier 1 deal is only getting signed in the first half, and even then in all likelihood it will be phased in similarly to the way Verizon was. So $2-3 million in the second half from the new Tier 1 is probably about right.

In other words, it looks to me like Radcom is guiding to known revenue only. They aren’t assuming anything incremental from AT&T. They are assuming no further expansion from Verizon this year. And they are assuming a slow ramp of the new Tier 1 in the second half.

I think they are setting themselves up for raises later in the year.

But I might be wrong. The other possibility is that guidance reflects an expected slow ramp of the NFV business for Verizon and other Tier 1. Given how slow it’s been for deals to materialize, this wouldn’t be that surprising.

It doesn’t matter (in my opinion)

Nevertheless, I don’t think it matters if this is a slow ramp or if it’s sandbagging. The only thing that matters here is whether I am wrong about these deals ramping to $15 million or more on an annual basis.

In fact with this latest Tier 1 win, deal size is the last leg for bears to stand on. They need to focus on the $5 million Verizon deal, assume that the deal won’t grow much more, and extrapolate that size to the other service provider trials.

Indeed if I am wrong and Verizon maxes out at $6 million or $8 million or this other Tier 1 maxes out at $5 million, then Radcom is going to struggle. But if these are $15 million plus deals, and because there is every indication that there will be more to come, then it’s just a matter of waiting until it plays out.

I just don’t buy the former scenario. It doesn’t make sense to me. These are large service providers. They are in the ballpark of AT&T and so the size of the deals should be in that ballpark when they are rolled out across the network.

Essentially, Radcom’s customers pay a constant, recurring and regular fee to use the vendor’s software, no matter how many instances they deploy and how many customers they are supporting with the software. So whether an operator is deploying Radcom’s probes in one market or ten, and supporting 50,000 customers or 5 million, the fee remains the same — the cost to the operator does not scale as it uses the software more. The traditional model of linking technology payments to boxes or instances or customer metrics doesn’t apply with Radcom.

I know I’ve been talking the Radcom story forever and I’ve been both very right and very wrong about it at various times. But unless someone can tell me why Verizon or Telefonica or Bell or any other Tier 1 wouldn’t have a deal size roughly comparable to AT&T, then I am going to say that right now things look as strong as I’ve seen them.

Therefore I am pretty excited about where Radcom is going. It’s my largest position right now. It’ll probably continue to be painfully slow, but the end goal seems clearer than ever.

Precision Therapeutics (AIPT) is roughly a $12 million dollar market cap company. They have 11 million shares outstanding and no debt. After a January share and warrant capital raise (which I am including in my share count) they should have about $4 million of cash on hand. They also have a $1 million note receivable from joint venture partner Cytobioscience.

The recent share and warrant raise diluted shareholders significantly. The placement was for 2.9 million units, consisting of shares at $0.95 and 0.3 warrants prices at $1 per share. This was a $1.50 stock as recently as November.

Precision raised the cash because they are burning cash. I estimate cash burn per quarter is about $1 million per quarter. This will probably continue.

Those are the facts, most of them not pretty. So why did I take a position?

The STREAMWAY System

Precision markets a medical fluid waste disposal system called the Streamway System. The system is a wall mounted device located in the operating room. During procedures surgical waste fluid is continuously removed via suction, passed through proprietary filters, measured and recorded, and then passed directly into the building’s sanitary sewer.

This is very different than traditional waste handling during procedures. Competitive solutions use mobile carts and disposable cannisters that have to be replaced, often multiple times during the procedure, and in many cases treated with gels to minimize the chance of contamination. Even so, accidents occur and they are expensive. Hospitals spend $4,500 on average for a mishap.

Here is a look at Streamway (Skyline is the former name of Precision) and its competition:

The Streamway system has a number of advantages over incumbent waste disposal options:

Price: Cost of the unit is similar to slightly less than competition (Stryker system plus docking station costs $34,000 though I suspect they have been discounting to try to squeeze Streamway), but the disposable cost is 1/2 to 1/8 of the cost of replacing cannisters

Safety: no chance to spill fluid or to have an accidental catheter removal during a cannister change

Labour: cannisters have to be changed during a procedure anywhere between 2-10 times. This is entirely eliminated with Streamway

Accuracy: can more accurately estimate volume extraction than the manual estimation using cannisters

Ease of use: removal of clumsy cannisters, latching, and replaces with simple instrument panel with instructions

Time: Procedures do not have to be stopped to replace cannisters which can result into 20-50% faster surgery

The primary negative with Streamway is installation. It has to be hooked up to the sewage line and therefore the operating room needs to be shut down and the wall cut open to complete the install. This has been a sticking point, particularly as hospitals are not unhappy with the mobile carts they’ve been using. Precision has taken to emphasizing the improved safety of using Streamway.

The cost advantage of Streamway is significant. This is from the last 10-K:

A study by the Lewin Group, prepared for the Health Industry Group Purchasing Association in April 2007, reports that infectious fluid waste accounts for more than 75% of U.S. hospitals biohazard disposal costs. The study also includes findings from a bulletin published by the University of Minnesota’s Technical Assistance Program. “A vacuum system that uses reusable canisters or empties directly into the sanitary sewer can help a facility cut its infectious waste volume, and save money on labor, disposal and canister purchase costs.” The Minnesota’s Technical Assistance Program bulletin also estimated that, in a typical hospital, “. . . $75,000 would be saved annually in suction canister purchase, management and disposal cost if a canister-free vacuum system was installed.”

A second study, by the Tucson Medical Center, found similarly significant savings. They estimated they would save $22,000 per year in a single operating room. Bottle costs for the mobile unit they had installed previously were $107 per procedure. The Streamway disposable cost brings that down to $24 per procedure.

In general, the $24 price tag is a favorable disposable expense compared to the costs of replacing cannisters, waste disposal, gel costs and labor for the competing Stryker and Zimmer systems. Those systems need to have cannisters replace anywhere between 2-10 times depending on the procedure. The material and waste disposal costs can be between $25 – $100 (or more) and on top of that there are labor costs and the time cost of having to pause the procedure to empty the cannister. You add to that the risk of a contamination event (which is going to be a $4,500 hit) and its easy to see how Streamway saves money.

Struggling Sales

So you can make the argument that Streamway is a superior system. Nevertheless the company has had a horrible time ramping sales. On the third quarter conference call the CEO Carl Schwartz, came clean about what had been happening:

When I took over as CEO in 2016 like many of you I thought the Streamway System was a slam dunk…Nothing could have been further from the truth. We had two very entrenched competitors, Stryker and Zimmer, who have their units at most hospital facilities in the country. In addition they were able to bundle their units in with other operating equipment, offering substantial discounts. Furthermore, it became increasingly evident that many institutional hospital customers would not allow us to connect to the hospital sewer system because they did not want us to open the operating room wall. Given these challenges and the fact that their unit and ours effectively removed fluids, what was our competitive advantage? After several months of effort we discovered that our most competitive advantage was our ability to avoid the spread of infection in the hospital by eliminating any contact between the infectious materials and the patients and staff and we have been hammering that home where ever we present the Streamway system and in newspaper articles all over the country. As you know it has been a slow going but we are making substantial progress.

In addition to pressure from the competition in the United States, the company has been slow getting regulatory approval in non-US districts. Up until this year their sales staff and list of distributors was sparse. It was a situation where you had a solid, superior product, but it was competing against well-funded incumbents, and marketing and sales dollars were not enough to mount an offensive.

In fact it seems like management had begun to give up themselves. There was a failed merger with Cytobioscience in the summer. There was a subsequent joint venture with Helomics and a proposed one with Cytobioscience. Indeed even the strategy for 2018 includes the following statement:

To expand Skyline’s business to take advantage of emerging areas of the dynamic healthcare market. To this end, management is implementing a Merger & Acquisition strategy focused on finding and acquiring high-growth companies that have established operations and the ability to drive both revenue and capital appreciation for the Company, or entering into strategic relationships with these companies.

Even if management was just being strategic with its new diversification approach, investors were frustrated. Listening to conference calls in 2017 is a painful exercise. Lots of frustrated investors, many of them long time investors, having been expecting a steep sales ramp, saw unit sales trickle in a 1 or 2 a quarter and the share price lag.

With cash levels dwindling, management had to raise capital with the dilutive raise I mentioned previously. That, along with the failed Cytobioscience merger, was likely the last straw for many investors.

As a consequence, the share price hasn’t done well. The one year chart illustrates the disappointment:

Things are turning

I’ve had Precision Therapeutics on my watchlist for the last 6 months. I can’t remember why I added it, I’m pretty sure it was mentioned by someone on twitter though I don’t remember who. When I looked at it a number of months ago I thought they had an interesting product but there was no indication that they were gaining any sales traction. So I passed.

However that appears to be changing. In early January the company announced that they had sold 5 Streamway systems in the fourth quarter. They sold another 6 systems in January alone. I wish I had been paying a bit closer attention to the company when this news release came out, as I would have probably started buying it back then.

I did pay attention to the second news release that came out last week. Precision projected 100 systems sold in 2018 from the United States alone. I caught the stock soon after it jumped on the news.

Precision sold 10 systems in 2017. This includes at least 1 system sold in Canada. So the projection for 2018 is for at least 10x 2017 sales.

While up until now sales have drifted aimlessly, the company has been doing a lot of work behind the scenes that has set themselves up for this type of increase. They have:

Hired 4 regional sales managers and a VP sales in early 2017. Up until the end of 2017 they had a single regional sales manager and no VP Sales.

Signed a contract with Vizient, which is a healthcare improvement company with a $100 billion in purchasing volume, in the summer

Partnered with Intalere, a health care supply chain manager

Signed a 3 year agreement with Alliant Health, a Service-Disabled Veteran-Owned Small Business that sells medical device products to the federal government, to sell STREAMWAY to into Federal Hospitals

And while early sales have been sporadic, they do mark first steps toward greater penetration, opening up the opportunity for more significant deployment once the systems benefits are experienced. Take for example, the two units sold in the third quarter. Both sales were to single operating rooms across much larger hospital networks, in one case a 6 facility network and in the other a 11 facility network. On the third quarter call Schwartz said they were in discussions to standardize waste management across each network.

Foreshadowing the increase in sales, Precision did 92 demos in the first three quarters and equaled that amount in the fourth quarter alone. They did 145 quotes in the first 3 quarters, and more than 75 in the fourth quarter.

International sales have been even slower to come then domestic, but in the last 6 months Precision has made some strides there as well. In June they got the CE mark for the system, which allows them to start selling the devices into Europe. Later in the year they partnered with Device Technologies, which will be selling Streamway in Australia, New Zealand, Fiji and the Pacific Islands (they seemed quite excited about the Australia opportunity on their third quarter conference call). They added a distributor in Canada as well as have been selling systems directly. They added another distributor selling into Switzerland in November and opened a European office a few days ago. Its worth pointing out that the 100 unit sales projection is not including any sales outside of North America.

One time and Recurring Revenue

Streamway systems retail for about $24,000 per unit. 100 units should equate to around $2.4 million in revenue.

That will be a big uptick from 2017 revenue. The company has been printing quarterly sales in the $100,000-$150,000 range for the last few years, so the 5 Streamway units sold in the fourth quarter and the 6 and January should provide a nice revenue ramp.

However maybe the more important consideration is that as more Streamways are installed into operating rooms, recurring revenue will scale as well.

Precision generates recurring revenue from the sales of disposable filters and cleaning fluid. According to the 10-K, the filter and fluid retail for $24. The company recommends changing the filter and cleaning the unit (with the fluid) after every procedure.

I think hospitals are doing this more like every 2-3 days. Nevertheless, Precision has been generating about $100,000 of revenue per quarter from the sales of the disposables. Given that there is about 100 units currently in operation, it works out to $1,000 of revenue /unit/quarter. While the company doesn’t provide margins from disposables, its pretty easy to estimate them. In the second quarter no Streamway units were sold, and the company generated $106,000 at 80% gross margins.

It looks like the average operating room performs 2-3 surgeries per day. If hospitals actually used the disposables after every surgery, I estimate revenue would be more like $4,300 to $6,500 per quarter per unit sold, or over 4-6x what I estimate it is now. That’s a lot of reason to promote proper usage.

Even at the current disposable usage rate, 100 extra units means $400,000 more high margin recurring revenue annually. Add that to existing consumable revenue, and add on the $2.4 million from unit sales, and I get annual revenue of about $3.2 million for 2018.

CRO Joint Ventures

Probably because Streamway sales have been slow, management has looked to alternative lines of business to boost interest in the stock. The initiatives kicked off in the summer with an announced merger with Cytobioscience, a contract research organization (CRO) that specializes in testing the cardiac safety of drug compounds. The merger was subsequently postponed in favor of a joint venture in November, and at the same time a second joint venture was announced with Helomics, another CRO company.

As it stands now, Precision has a 25% ownership stake in Helomics and a $1 million loan to Cytobioscience. The joint venture with Cytobioscience was supposed to close by year end but I haven’t seen anything to that effect. Listening to the last conference, it seems like even the merger with Cytobioscience may take place once audits and accounting work are completed (it was suggested that the merger didn’t transpire because of auditing required on Cytobioscience before it could be merged with a public company). On the other hand this article, which I can’t read in its entirety, says that Cytobioscience walked away from the merger, so who really knows.

I don’t know what to make of these two joint ventures and the move into CRO. It seems like the CRO business is growing. Whether these companies are at the forefront is anyone’s guess. Cytobioscience said on the second quarter call that they expected $700,000 of revenue a month by the first quarter of 2018. Helomics, which specializes in customizing cancer treatment based on finding patterns with their patient database, is in a growing field.

I’m also not entirely sure why these companies want to merge with Precision. The Streamway doesn’t really have a strong connection to the CRO businesses that they operate from what I can tell. Precision does have net operating losses of $11 million that could be utilized against future profits. So maybe that’s it?

Just last week the Economist dedicated an article (and a cover) to the emerging field of using data to provide better diagnosis and treatment. The article talks about using AI to better customize treatment to patients. That is essentially what Precision will be trying to do in their partnership with Helomics.

Summary

Cash on hand should be enough to get Precision through 2018, and maybe further depending on how these sales develop and how much they end up spending on partnerships. If I ignore cash, the price to sales (P/S) multiple that the company trades at is 3.5x. Including cash its more like 2.5x.

Given the growth (10x the revenue in 2017), the margins (gross margins of 80%), and momentum in engagements across the United States and internationally, this doesn’t seem out of line to me.

The stock is hated by investors because it has disappointed for so long. There is a long list of bashers I’ve seen on twitter and a few on SeekingAlpha. None of these bashers have brought up a point that has concerned me though. They are mostly just rehashing past price declines.

I think the stock moves higher. At the very least it should get back to its November levels, which were above $1.50. If there is evidence that the strengthening of sales of Streamway is sustainable over multiple years though, that should just be the beginning. The recurring nature of the disposable sales adds a lot of value as more systems are installed. Finally, if the Cytobioscience merger becomes a “go” again, that would be another catalyst to the stock.

So you have a beaten down stock, pretty clear indications of sales momentum, and the outside chance that something bigger is announced. All around it seems like a decent bet.

Note: I have been told there is a SeekingAlpha article by Jonathon Verenger on Precision that is quite good. I haven’t read it yet because I wanted to write up my own ideas first without influence.

Follow Blog via Email

Enter your email address to follow this blog and receive notifications of new posts by email.